intensification of the general run on the international banking institution. that is a significant concern. as i talked to the commission when we met a year ago there were a number of other features of aig that were also concerned but that was an important one. >> so in other words, in addition to the real credit exposures and financial difficulties that might have been expected there was uncertainty about what the exposures were and what institutions had them, how much they were, lack of transparency in this market, in essence fueled the panic. >> absolutely. >> you quite appropriately in your testimony distinguish

between derivatives transactions themselves and the infrastructure for trading clearing, settlement of those instruments. .. add to the transparency of the process. and the safety through margins and market to market. in your view, was the trading in -- of derivatives over-the- counter as opposed to exchange trip -- exchange trading in derivatives a problem that posed

some risk because of the lack of transparency? because of the existing of counterparty risk in the over- the-counter arena? >> yes, certainly. aig is the poster child for that. it was not so much the losses that the counterparty experience on the movements in the group -- in the derivatives, but the counterparty risks that were the problem. the fed was quite concerned about settlement arrangements for derivatives prior to the crisis. teer one settlement arrangements in the federal bank of new york and a lot of work to try to improve arrangements for credit derivatives and also some other types of derivatives. and we were very supportive of the provisions in the recent financial reform legislation to standardize derivatives and put

the month until counterparties and the lake. the point that should be making a know you fully recognize if you're going to concentrate counterparty risk in central counterparties, that they must be saved. and for that recently that it was important to entitle the fed and other agencies work together to make sure that potential standards for a post on this counterpart -- central counterparties as well. but i agree with what you just said. one final comment is that another area where the are active in strengthening the trading boat in the capital requirements for banks, which essentially will make it more costly to the extent that things still use over-the-counter true for days the capital costs will be higher, reflecting the underlying risks, both counterparty and fundamental risks. so that's another incentive to put these instruments on exchanges. >> we have heard from the fed --

the federal reserve staff yesterday about interconnectivity of large financial institutions through their counterparty exposures and oct derivatives, contracts and that the relevance of that in assessing systemic risk of those institutions. and i wanted to ask you about lehman brothers, for example. and you have said if it had been -- you knew before it was allowed to fail as this failure would be catastrophic. in mr. baxter said yesterday that there was a significant concern beside it the otc

derivatives market would be severely impact to pay the failure. was this a concern of yours with respect to lehman brothers? didn't also enter into your concerns about bear stearns and wachovia and other large institutions with concentrated derivatives positions? >> yes, it's not the only aspect of interconnectedness. there's a lot of a lot of funny relationships on so on. but it certainly is an important one. it's very difficult to unwind these positions and when you lose a counterparty, then you have to replace your protection. and so, it was a significant concern and one indication of

our concern about lehman was we took a lot of steps to try to put foam on the runway so to speak is the expression went. and one of those things is to work with otc markets to get them to address these concerns. another dimension of this, by the way, what are the things we got to work out very quickly with the credit default swap's in lehman that others were trading and trying to range for settlements of those as efficiently as possible to get into problems with counterparties and ambiguity security that itself is a fairly complex process. so the short answer to your question was this was an important aspect certainly for the investment they, lehman, bear stearns and a certain extent to the other institutions that have broker-dealers in this kind of exposures. >> and i just have time for one last -- >> two minutes at >> that would be fine. with respect to these concerns,

i assume that the concerns went beyond credit default swap's two-out over-the-counter derivatives. as you know, credit default swaps were relatively small amount of the over-the-counter world of two rivet is at that point. and there were massive connections with other kinds of over-the-counter derivatives between the big dealers like the investment banks and their counterparties. and that the same problems of potential credit exposure, lack of transparency, potential, concerns about what the exposures were applied generally to the whole over-the-counter derivatives market.

>> yes, there is some types like equity trivet is that shared some of the problems, operational problems they had in terms of clearing the settlement. the more generally, when they spoke derivatives, for example, you had both counterparty risk and he also had the complexity of trying to value the positions and that becomes serious when you're trying to come in a crisis, trying to figure out what exposures are and whether a company can solve it or not. so, yes. >> thank you. >> mr. hennessy. >> thank you. thank you, mr. chairman. yesterday mr. fuld argued it was unsupported by the reality of the day. we heard the same thing from bear stearns that there found was financially healthy and they're what down by whispers

and rumors and unsubstantiated fun. i believe i heard you just say it that lehman is probably insolvent. in your view, did lehman and they are fail all my because of unjustified the quiddity runs or were there also general solvency problems that arose? >> so as i said before, one of the reasons the ceos also coincided with there is a general planet. it was obviously general financial crisis that will put the companies under extraordinary strain. that being said, there were certainly a hierarchy and weaker companies were certainly the first to feel pressure. the bear stearns is widely viewed to be the weakest of the investment banks and lehman was widely viewed to be the second weakest and so on. and they were clearly lost his in the quiddity issues that those companies. in particular, in the case of lehman, they had raised some capital and the spring, but they

have not succeeded in spinning off a substantial position that a lot of embedded buses and they've not succeeded in raising additional capital that they were able to persuade new investors to come in. and so it was a combination of general feel, certainly, but also some legitimate concerns about both the asset position of the company. you know, its balance sheet, but also i think some concerns about the longer-term viability of the firm, business model and other issues that are concerning hoax as well. and it's the nature of financial institutions that they live on compliments on their counterparties and customers and predators don't believe there is sustainable, then the pressure amount greatly. >> i hear a lot more discussion on how to present prevent

failure and what will happen and what failure occurs. now the government has a new resolution authority at one point these large non-bank financial firms will have living wills. but those mechanisms are not yet in place. it takes time to implement them. we were discussing force of the international aspects of resolution authority which i imagine our nightmarishly complex. and at the same time, you're 13 authorities are curtailed and they won't be t.a.r.p. around. are you confident that the government, including the fed has the tools and means to deal with a failure of a too big to fail for if and when they should next occur? >> while i prefer that to be tested in the next few days if you wouldn't mind. that being said -- >> i hope i won't be the case. >> that being said, the fdic has

embarked on this at admiral urgency at chairman bair will tell you in a little while and then moving to set up the rules which we needed to implement this and it's not only a question of implementation, but i think the benefit of this and i'm sure mr. wallison would agree to have been certainty in advance about how the process will be run and what the effect will be on predators and so on a firm. so it is a work in progress right now for sure. but we're working very quickly to try to put it into operation. >> if i could come is it just a timing thing of getting his mechanisms up and running. if you don't have the ability to provide a firm number anymore and the t.a.r.p. isn't there to provide capital injections, is

there a scenario which you might meet the money into a firm where there is or is not a tool to actually do that? >> remember the treasury can provide the loan as long as it's repaid, either from the company in receivership or if necessary from an assessment of the financial industry. so if money is needed to prevent the disorderly failure or to facilitate the bridging process, et cetera, then the government can provide that. and the fed meanwhile is of course limited in our ability to go beyond just our normal lending to a sound company. but that was a change we were comfortable with as long as these alternative authorities were provided. systemic risk. i hear a lot of people talk about it. i haven't heard a precise definition other than people usually say it means risk to the system, which doesn't --

[laughter] and i understand there's always going to be discretion involved in than it's been much more of an art than a science. are there efforts underway or is anyone dead in the good work in trying to turn this from an art to science to eventually some sort of engineering where you can measure this and analyze systemic risk? >> yes, there is right now and academic research literature looking at some of these things, trying to identify, for example, with some of the material are, how big, how connected, those sorts of things. or some criteria involving things like correlation, how correlated it is a stock of company acts with other shares of other companies and what does that say about it systemic importance? dearth of academic literature under way. the federal reserve has to set up a set of rules that will govern how we recommend to the oversight council which

companies are to be treated as systemically critical for the purposes of oversight. and so we're going to have to read which puts down on paper, in a way that is likably sensible what are the criteria were looking at. so to some extent, it also remains subjective and the criticality of the firm depends on the environment. so our decisions vis-à-vis his own firms redress in a calm environment. for the overall economic and financial betterment matters, not just the firm. but we are cognizant we need to be more specific. as i said there was literature to draw and we have a project in the fed right now trying to write this ruled that will govern our recommendations. >> good. i'll end with an easy one. other then your speech is, what do you think are the most

important writings on the crisis of the whole? if you could recommend that people read two or three really good speeches, books, papers, whatever they happen to be. what are the most important are underappreciated work? by the way that pre-pre-13 when i book comes out. >> i think there's a lot of interesting work. i know you're familiar with sort of the narrative histories and so on and i won't bother to go over those, but i cannot stand to profit cereal, there's an interesting academic work already looking at these issues and i even made reference in a testimony to carry gordon's work, where he is pretty clear to identify the analogies between what happened to the shadow banking system and classic tinkerings, 19th 19th century style bank runs. i think those are interesting. there's also quite a bit of

interesting work, people like marcus britton meyer at princeton, which looks at the turning max of a panic in the repo market and how the cycle of increasing haircuts and margin were. and he and others have also done the the work or for trade moment ago in trying to identify critical firms are looking at their characteristics. maybe i could come up with a few other things given it a little bit of time. but there is some interesting work underway in this area. >> could you provide is chairman bernanke's fall pretty messed? >> only if you take a test on it. last night we're taking a test. >> all do that. >> and we may post this on the website feature benefit day. all kidding aside, there would be great if there were few pieces. >> if you understand the lord a finance book which was pulitzer

prize of the history of the great depression and you feel sometimes this seems awfully familiar. >> ms. marin. >> thank you. and thank you, mr. chaiman for your time today. my question begins actually in your written testimony for you referenced the glamour each bliley act by having limited to regulators to get any enterprise of risk in financial position and activities. and i was wondering if when you think to back to how the crisis unfolded, part of our churches determine what caused it. in your mind, does the fact rise to the level of causation or isn't simply one of many fact there is were part of the whole unfolding of the crisis? >> i think it was one of many factors. and you could point to specific examples where cost problems. for example, the fed was

somewhat reluctant to examine nonbank subsidiaries, bank holding companies, feeling that the sense of the love we needed to do for whoever was nominally the regulator. and so, for that reason, we were probably not as aggressive as we should have been in identifying some of these were issues that arose from mortgage companies and other nonbank lenders. for that would be one example. another example, which is more complex, has to do with the role of off-balance-sheet vehicles. and this turned out to be a big problem and not under the existing accounting -- under the existing accounting rules at the time, but the bank did not have a majority ownership of an off-balance-sheet vehicle, it didn't have to consolidate that

vehicle and its capital charges were limited only to explicit commitments of liquidity or capital to the vehicle. and so, in actuality, it turned out the exposures of the vehicles were much greater than understood because the banks themselves to have monitoring systems and also because in the event for reputational reasons they often came to rest you these few clothes as i got into trouble, even though they weren't contractually obliged to not cost them money as well. and so, there were some -- i think a little bit of uncertainty about giving it thought she vehicles might have been sponsored by the bank, which therefore would make them responsibility some sense of the providers like the occ, but they were obviously also part of the overall holding company. you think there was a little bit of uncertainty of whose responsibility these were immediate was not sufficiently

aggressive potential paid to those off-balance-sheet. i'm sure there was not attention paid to the saatchi balance. i think there were some things that fell between the cracks. i wouldn't want to elevate it to the principal cause of the crisis, but it was one of the reasons that some of the risks that face the overthrow overall companies were not appreciated. >> in a bind with the new legislation is recently passed, had that been in place at the time, but actions would've been taken that might have been different or what would've been different about the body of knowledge that you another regulators might have had that would've allowed you to act perhaps more preemptively? >> well, i think the clearest cases the nonbank subsidiaries were we, for example, did not -- we only began a pilot program to look at nonbank wending subs in 2007 or so, working with the

other regulators of the substring to identify consumer protection issues. in the absence of the gop i think we would've been earlier looking at some of those problem areas and less reticence going into those. again, the issue of off-balance-sheet vehicles is more complicated, but i think that the situation in the legislation now, rather than letting these issues fall between the cracks, especially gives multiple responsibility that says you have to post look at this is more likely to identify those problems in the future. >> thank you. another question just to touch back on something earlier which was the housing bubble. could you talk about your feeling as to the relationship between securitization of the housing bubble? the america think there was a relationship. so securitization was the other end of the originate distributed

model. and there's a big sea paradise project that came from foreign investors, but not entirely of course, to create the wrong material for security is a tax, you had to have lots of mortgages be made. and as a result, to expand the number of potential homebuyers come you had to lower the standards. so you got increasingly weak underwriting and more and more exotic mortgage instruments being used to expand the number of people who could get mortgages and therefore buy houses. and what this did was -- i don't member the exact number, but this is very substantial action of the mortgages issued in 05 come a 06 were released nonprime mortgages and that obviously increased the overall demand for houses. so you see a chain going from the demand for securities

products, the demand for material to pressure to weaken underwriting standards to expansion of a number of people borrowing to increase house prices. another was a circle because again as house prices rose, lenders became more comfortable making more risky loans. and not just was a self-fulfilling prophecy of this until prices cut to the point where they can be sustained any further. so there was indeed a connection there. >> for your feeling is really where the demand of us driving the process as opposed to the push from the originators who stood obviously to do rather well in that environment where they could continue to originate mortgages? or do you think it's both clacks >> so, i figure there's a push would've come not so much from the ultimate mortgage makers who themselves are agents of the bank for investment banks. there was probably some push coming from the folks who were creating the securities products, the salesman going out and saying he's an attractive

investment vehicle. it's rated aaa. so there certainly was some pressure coming from outside. but clearly there was an awful strong demand is domestically and abroad for given how low, in particular, you know, given the treasury yields are pretty low and given the demand for longer-term states fixed income assets. that demand, hardly from abroad, drove wall street to come and you know, to create these products, to satisfy that demand. >> teeny mac. >> you're welcome. >> all right, mr. chairman, just a couple of quick wrapups items i know very quickly member giorgio and also senator graham have a couple of quick questions. and i want to ask you about historically and going forward, we talked about the challenge of the factory is too big to fail

institution and going forward we have institutions that may be not only to date, but too few to fail. fewer institutions, larger scale. and there be a challenge of political will for regulators to be as tough as they need to be. it seems to me there was and is in the company in question and that is one of resources. and adjusting resources in sheer numbers. i mean, let's be blunt about it. a lot of the wall street guys are likely spades. they're hard to catch. and you know, there's many new products. sometimes even call it innovation. as you noted, that may be a kind word in many respects. and i guess my question as to what extent was the kind of mismatch here a problem and both will be the future? and i don't just mean come you know, there's been a damning nation of the ethos of public service. it's been growing compensation deaths. in the public arena as we all know it's no picnic. and i guess my question is, what is your confidence level that we

can chart resources. i saw almost no debate during dodd-frank of the talent level you need to be able to have effect of oversight. and to what extent was not a problem and will it be a problem? >> no, it's a very good question. and you're right that we can't outspend wall street in terms of hiring people, obviously. i'm a very strong incentives to evade regulation in certain circumstances. just a couple of comments. one is that this is one of the reasons why haven't the market discipline both be very helpful. we need to have the additional set of eyes that comes from investors and what we see spread open enough for stock prices going down, that's a signal we should pay attention to because clearly have very talented people who are in the markets and are assessing these firms. and their information is transmitted to prices we should pay close attention to that.

the other comments and i think one of the things we learned from her stress testing this in other areas is that we willingly choose all our resources geared so it's one thing to have experienced supervisors and collectively among us and the fdic and the occ we have a cadre of experienced supervisors, but given the institutions and global capital flows and like a movie to bring another expertise as well. and so we have come at the side, we have -- as i said come with taking a rumbled to disciplinary and buy him some financial and other experts to support the supervisor for. so i think i will be helpful. and mr. thomas mentioned how the fed had come to know, retained a lot of supervisory authority. i think one of the reasons for that was because we have a lot of those skills, which are going to be necessary to make this work. all that being said, you know,

it's just simply never going to be the case that the government can pay willful streak and pay and we're going to have to work very hard and watch very carefully to make sure, you know, that we are successful in oversight. again, we don't have to replicate every business decision or evaluate every asset. we can't do that. so we can try to do was make them convince us that we have systems and management in place of a plausibly deliver the right answers and give us confidence to do in the right thing. but you're absolutely right this is a poor issue of practical matters is we try to implement this fall. >> final question for me and it's something we've talked about and we've talked about internally. i know my friend john thompson and i have wrestled with this a little. he talked about the magnitude of sometime monday.

.. what was the dominant phenomenon? was that the toxicity or the fragility of the system? was it though infection or the weakness of the body? >> it was triggers vs vulnerability is. part of the reason -- if we had

a healthy, strong, stable financial system, it could have accepted this problem without creating such a major crisis. i believe very strongly that it was not subprime lending perce. it was that the system as a whole had structural weaknesses. if you like, the people i get into the food supply and created a much bigger problem -- the e. coli got into the food supply and created a much bigger problem. >> the fact that it cut into the most widely eaten food product, was that -- did that exacerbated or was it the securitization that exasperated it? could it have happened with other asset class is? the unique features, what were they to allow the system to must back to stop -- to must at the

size -- to mask the size -- to mastesize? >> this magnitude would not be big enough. what caused the crisis was many things, but it was the e. coli effect -- there was an awful lot to dependent on short-term funding. since these deposits were not insured, they were prone to run. when people think there is something wrong with the assets they are lending against, even if they are only 1% or 2%, they will take their money out. why should they lend against a potentially risky product? that forced people to go into

liquid products. i think this is more of a trigger, the e coli, than the factory itself that would have caused the system to seize up. igger the e. coli than the fact is that itself would have system to seize up. >> chairman georgiou, for your remaining -- >> thank you. to follow-up on that, dr. bernanke, another problem what a great deal about in our hearings was this notion of regulatory arbitrage and capital arbitrage, where institution held assets off-balance-sheet to avoid capital requirements. in some cases mischaracterize assets to put them into categories that require them to hold less capital under the rules. you know, we talked about safety at its peak, if you brought on in all the dispersed assets had some 3.3 trillion in assets with roughly $75 billion in capital, which is a little only over 2%.

the third of that got used in one liquidity put on one set of cdos. obviously, in hindsight almost everyone agrees including her predecessor as fed chair that more capital less leverage would have been media rated the financial crisis. it may be facile to say the system would've been safer, been required to raise and hold more capital but the mere fact it's facile is not astounding make it untrue. i wondered if he details what the feds use are going forward regarding capital requirements and what particular provisions to put in place to insure that the financial institutions that have grown so large and are prone to be rescued are well capitalized on a go forward basis? >> thank you. i think it's important when you think about the situation going forward is recognize that there are two big things happening. one is the financial reform legislation recently passed in the u.s. congress and signed by

the president. the other is a substantial reform of international capital standards which is currently going on and i will be attending the basel meeting next week in switzerland. so the united states agrees, secretary geithner is talked about this, we agree, secretary chairman bair, that stronger capital standards are essential as one of the key components going forward to ensure the safety of the system. and so what we're talking that with their international colleagues in basel now is first having more capital, having higher quality capital, that is not using intangible assets and other things that are not loss of serving as capital, making capital for risk sensitive so that it responds more to losses and absorbs losses more effectively, creating some counter cyclicality in capitals, capital can be built up in good times and run down in bad times.

and, finally, we are working with the accounts and others, you know, we've gone beyond the situation you talked about, where citi had always off-balance-sheet assets which were not consolidate has been very largely changed now by new accounting rules. which will require consolidation where there is substantial ownership of those assets. on top of that we are looking for international leverage standards and international liquidity standards. we expect of some very substantial improvements in those regulations. internationally create a level playing field and i do believe as we go forward those rules and their implementation will be the same order of magnitude and importance of ensuring a safe financial system going forward as the changes, very important changes, been made in the recent legislation. >> thank you, dr. bernanke. >> senator graham, a quick closing question?

>> yes. chairman -- [inaudible] spent the chairman answered the question i was going to ask, which related to what is the status of off-balance-sheet items. but i cited earlier a report that there seems to be a weakening of resolve i a basil group in terms of liquidity and capital standards. does that coincide with what you're hearing, and if so, do you think that we can participate adequate resolve at the international level to get the standards where they need to be? >> so when you're developing complex and capital standards, it's important to consult with the banks to understand, make sure you understand what indications are for how much capital they hold and how it will affect their business and so. it's important understand that you're not making good policy if you don't understand the implications of your decisions.

that being said, that's not the same thing as weakening standards. we want to make sure the standards are rational and effective. and we are committed to very strong standards, and i think you will see when they come out that they will be substantial improvement over the standards that we've had the last few years. >> thank you. >> just one question. bank regulars have for many years been concerned about fair value accounting, mark to market accounting. and some have said that have something significant to do with what happened in the financial crisis. what's your view of that? >> well, i think that mark to market accounting at times increased the procyclicality of the system there were times when markets were highly illiquid and it was very hard to value assets.

that being said i think we should do our best to get appropriate market values of assets that do not market prices. this is a somewhat different issue when you're dealing with long-term credit in the banking book. where there is no secondary market and appropriate valuation requires, yeah, a model are some assumptions. i'm in favor of accurate accounting. i think that there are sometimes problems when markets are very illiquid and the fasb tried to move in the direction of clarifying how to deal with so-called level three assets and illiquid markets. but i'm also very cautious about mark to market accounting to the long-term loans, the bank loans, the banking loans of the banks. if i could say one quick thing about a question you asked me before. i would just point out that the decisions there, the interventions are there were fdic decisions. they must've made, i'm sure they

make independent judgment about the best way forward. they're concerned about protecting the deposit insurance fund. i'm sure they're trying to find the least cost solution to that. >> my question, thank you for that, but my question really was what importance do you think market to market accounting might have had in the financial crisis as we understand, that is, this huge decline in asset values? >> i think it exacerbated it somewhat, the nature of financial markets that asset prices move up in booms and down in crashes. that is an exacerbating factor, but, you know, we don't want to sacrifice accurate valuations to eliminate the issue. i don't think you could. so it was an issue, but i don't think we should abandon mark to market accounting. >> mr. chairman, thank you very

much for this second appearance before us. during our deliberations i also want to reiterate something that the vice-chairman and others have said. douglas holtz-eakin i know mentioned specifically, you understand and the federal reserve have been very forthcoming, very cooperative in terms of providing documents information, we appreciate the way in which you have helped conduct, us conduct our investigation, our inquiry for the benefit of the american people and for history. you have been very good in this regard and we look forward to continue to work together as we do our final report. thank you very much for being here this morning. >> thank you, mr. chairman,. >> will now take a 10 minute break, members. and then chairman bair will be before us. [inaudible conversations] [inaudible conversations]

>> the first meeting in nearly two years between leaders of israel and the palestinian authority. from earlier today, a briefing by secretary of state clinton. after that, special lawn boy george mitchell briefs reporters after the meeting -- special envoy george mitchell briefs reporters after the meeting.

>> we will have house senate and governor's races with charlie cook. at 9:00 p.m., a debate between the senate candidates in california. barbara boxer and carly fiorina. they say this race is a tossup. and the candidates for the governor of arizona. that is at 10:00 p.m. eastern at 11:00 p.m. eastern, a debate between the candidates for governor of nevada. harry reid and brian sound of all. about there's nothing

finance that is like a rocket science. you think about ponzi schemes. the biggest one for wall street is telling someone who has worked really hard to earn a buck that they are not good enough to understand how that dollar is going to be invested. >> this is our guest sunday night on c-span is q&a. >> search the term mideast peace and you will get more than 1700 programs and more than hundred transcript. interviews, panels, and forms, all the way up to this week's white house middle east peace talks. >> leaders of israel and the palestinian authority have met

for the first time in at least two years. president netanyahu and president abbas have met for peace talks. they were joined by secretary of state hillary clinton and middle east peace envoy michel. -- george mitchell. [applause] >> good >> good morning. i want to thank all of you for joining us today. we are here to launch negotiations to settle the

israeli-palestinian conflict. to settle the israeli-palestinian conflict. i note that getting everyone at this table was not easy. we understand the suspicion and skepticism that so many feel, born out of years of conflict and frustrated and hope. a tragic act of terror on tuesday and the terrorist shooting yesterday or additional reminders of the human cost of this conflict. but by being here today, you each have taken an important step towards freeing your people from the shackles of a history we cannot change. moving towards a future of peace and dignity that all you can

create. so thank you. thank you for your courage and your commitment. i also want to recognize the support of egypt and jordan, which have long been crucial partners for peace. we appreciate the support of the arab league. i also wish to thank former prime minister tony blair, the special representative of the quartet, for his leadership and ebert. mr. blair's work in support of the institutional and economic development of the palesnian people is critical to the success of these peace efforts. as we have said all along. -- as we have said l along, progress must go hand in hand

with progress in gotiations. let me also, as represented by this overwhelming turnout of representatives from across the world, express our gratitude to many frids and allies who have worked so hard for progress towards our shared goals. to those who criticize this process, who stand on the sidelines and say "no," i asked you to join us in this effort. as president obama said yesterday, we hear often from those voes in the region to insist that this is a top prioritynd, yet, do very little to support the work that would actually bring about a palestinian state. now is the opportunity to start contributing to progress. for our part, the united states

has pledged its full support for these talks. we will be an active and sustained partner. we believe, prime minister and present, that you can succeed. we understand that this is in the national security interest of the united states that you do so. but we cannot and we will not impose a solution. only you can make the decisions necessary to reach an agreement and secure a peaceful future for the israeli and palestinian people. now, for many of us in this room, this is not the first trip to the negotiating table. i look around and i see veterans from all three. we have been here before, and we kn how difficult the road

ahead will be. there undoubtedly will be obstacles and setcks. those who opposed the cause of peace will try in every way possible to sabotage this process as we have already seen this week. but those of you here today, especially the veterans who are here today, you have returned because you have seen the cost of continued conflict. you know that your people deserve the benefits of peace. the core issues at the center of these negotiations -- territory, security, jerusalem -- will get no easier if we wait, nor will the results themselves. success will take patience, persistence, and leadership. the true test of these

negotiations will not see their first day and will not be their st day. it will be all of those long days in the middle when the past -- when the path towards peace seemed hidden and enemies helped to keep it obscured. we are convinced that if you move forward in good faith and do not wavered in your commitment to succeed on behalf of your people, we can resolve all of the core issues within one year. you have taken the first step. you have both embraced the idea of a two-state solution, which is the only path towards a just, lasting peace that ensure security and dignity for both israelis and palestinians. i fervently believe that the two men sitting on either side of me, that you are the leaders who

can make this long-cherished dream a reality. we will do everything possible to help you. this is a time for bold leadership and a te for statesmen who have the courage to make difficult decisions. mr. prime minister, mr. president, you have the opportunity to end this conflict and the decades of anger between your people once and for all. i want to conclude by saying a few words directly to the people of the region. your leaders may be sitting at the negotiating table, but you are the ones who will ultimately decide the future. you hold the future of your families, your communities, and your people, this region in your

hand. for the efforts here to succeed, we need your support and your patience. today, as ever, people have rally to the cause of peace and peace needs champions on every street corner and around every kitchen table. i understand very well the disappointments of the past. i share them. but i also know that we had it within our power today to move forward into a different kind of future and we cannot do this without you. so now let me turn to the prime minister to will make his remarks, paul led by the president.

-- followed by the president. >> thank you, madam secretary. i want to thank you and president obama for the many efforts that you have invested toring us to this moment. my friend, senatoritchell, thank you for your consistent efforts. for bringing a lasting peace to our region. president abbas, as i sd yesterday in our meeting at the white house with the president of the united states, the president of egypt, and the king of jordan, i see in you a

partner for peace. togeer we can lead our people to a historic future that can put an end to claims and to conflict. this will not be easy. a true pce, a lasting peace would be achieved only with mutual and painful concessions from both sides. from the israeli side, from the palestinian side, from m side, and from your side. but the people of israel and i as their prime minister are prepared to what this road and

it to go a long way in a short time. we want to achieve a genuine peace that will bring our people security, prosperity, and good neighbors. good neighbors. we want to shape a different reality between us. this willnvolve serious negotiations. there are many areas of contention. there are things we have disagreements on, but we have to get from this agreement to agreemen two years ago -- rather a year ago -- in a speech i gave at the university in israel, i tried to

outline the two pillars of peace that i think will enable us t resolve all of the outstanding issues. these are legitimacy and security. just as you expect us to be ready to recognize a palestinian state as a nation-state of the palestinian people, we expect you to be prepared to recognize israel as the nation-state of the jesh pple. there are more than 1 million who have also rights in israel. there is no contradiction betwee a nation-state that guarantees civil rights and

civil equality of the minority. i think this mutual recognition between us is indispensable to clarify to our two peoples that the conflict between us is over. i said to yesterday, a real peace must take into account the genuine security needs of israel that have changed. they have changed sense -- last year we spoke abouthe veterans who were gathered here at this table. we have been here bere. we-and the have run agreement -- we fashioned the hebron agreement.

we have had the rise of iran and missile warfare. a peace agreement must take into account security arrangements against the real threats that have been directed against my country. 12,000 rockets had been fired on our territory and terrorist attacks go unabated. president abbas, i am fully aware of your people's desire for sovereignty. i am convinced that it is possible to reconcile that desire with israel's need for security. we anticipate difficult days before we hieve the much

desired peace. the last two days had been difficult. there were -- they were exceedingly difficult for my peoplend for me. blood has been shed. the blood of innocents has been shed. for innocent israelis were gunned down brutally -- four innocent israelis were gunned down brutally. two were wounded. there are seven new orphans. president abbas, he condemned this killing. that is important. no less important than binding the killers. and equally, to make sure that wean't stop other killers. they seek to kill our people, kill our state, kill our peace.

and, so achieving security is a must. security is the foundation of peace. without it, peace will unravel. with it, peace can be stable and indoor. -- peace can be stable and endure. president abbas has given ua rare opportunity to end the conflict between our people -- a conflict that has been lasting more than a century. it is an unprecedented opportunity to end a century conflict. there have been some examples in history, but not many. we face such a task. to end the bloodshed and to secure a future of promise and

hopeor our children and grandchildren. in the first book of the bible, the book of genesis, there is a story of how two brothers in conflict -- brothers -- joined together to bury their father, abraham -- our father. the father of our two people. i sit, the father of the hebrew aac, the father of the hebrew nation, and ishmail, the father of the muslim people. can only pray -- and i know that millions around the world,

millions of the israelis and millions of palestinians, and many other millions around the world prayed that the pain that we had experienced, you and us, in the last hundred years of conflict, will unite us, not only in a moment of peace around a table of peace here in washington, but will enable us to leave from here and forge a durable, lasting peace for generations. shalom, salaam, peace.

>> in the name of god, madam secretary hillary clinton, and prime minister netanyahu, ladies and gentlemen, let me once again extend my thanks to president barack obama and to senator george mitchell and there came for the unrelenting effort they have exerted. the negotiations between the

israeli government and the palestinians -- now that we are launching these negotiations, we knowow hard it will be. these negotiations should, within a year, lead to an agreement of the legality between our peoples. it is encouraging. what is giving us confidence is that the road is clear in front of us. the road is reckoned -- is represented by the national security council and the league of nations.

ladies and gentlemen, because we have had many rounds of negotiations, we have studied all horizons and we also defined all of the pending issues. the settlements, the borders, security, and detainees -- in order to create the state of paleste that rest side-by-side

with israel. we want to bring peace and security to all the peoples of the region. once again, we want to state our commitment to security and ending the fighting. we call on the israeli government to go forward wh this commitment to end all settlement activity and completely lift the embargo of the gaza strip. also, with respect to security, we have -- we are doing everything expected from us.

we did not only condemn the terrorist activity, but also followed the perpetrators and found the car that was used. we will continue all efforts to take security measures in order to find the perpetrators. we consider security important for both of us and we cannot allow for anyone to do anything that would undermine your security and our security. we, therefore, not only condemn, but we keep on working fervently. ladies and gentlemen, once again, i want to state today

what i said at the white house meeting yesterday in front of president mubarak. we believe their participation was very strong. these two states, along side with other arab states, do believe that peace is of vital interest, not only for the palestinians and israelis, but also for all countries in the region and for the united states. president obama said the creation of a palestinian state is of vital national american interests.

we are adamant about bringing peace, freedom, and independence to the palestinian people. a fair solution with the problem of the refugees, we have attached a resolution. we want to have a new era in our region. an era that brings peace and justice to all. let me say, in 1993 on the night of september -- on september 9, we signed an agreement. it was a document of mutual

recognition between palestinian -- between palestine and israel. this document was signed. in this document we showed that our intentions are good. our intentions are to recognize the state of israel. also, commitments were required from us. we respect our commitmen and our agreements. therefore, we start from here to reach a peace that will end the conflict. we wl meet the demands and start a new era between the

israelis and the palestinian people. thank you and make peace be among you. >> i want to thank both leaders for their statements. i also want to thank the members of their respective teams who are here in both delegations. the people sitting here have worked very hard, some for many years, and they have travelled a long way to be here. we are grateful for their commitment. today, president obama and i, as senator mitchell, and our entire team are prepared to do what ever we can to help you succeed. we believe in you and we support you. again, let me thank you for being here. now it is time to get to work. thank you very much. [captioning performed by national captioning institute] [captions copyright national cable satellite corp. 2010]

[inaudible conversations]

>> george mitchell said israelis and palestinians believe they can conclude peace talks within a year. this is a half hour. >> good aft foot afternoon and welcome. we have real launch direct

negotiations among the u.s. stands israel and the palestinian authority in pursuit of a final agreement, a final settlement and a just peace. to states living side-by-side. george mitchell will give a statement and answer a few of your questions, but we still have meetings go on with the parties, and he will have to return upstairs rapidly to rejoin the negotiations. here is a goat -- here is senator mitchell. >> good afternoon, ladies and gentlemen. the parties have just concluded the first round of trilateral talks. the meeting lasted about an hour and a half. it began with a plenary session involving the full u.s.-israeli- palestinian delegations on the eighth floor of the state department and then broke to a

smaller meeting in the secretary of state's personal office involving prominent -- prime minister that the not too, president abbas, secretary clinton, and myself. prime minister netanyahu and president abbas then went into a separate meeting for an eighth direct discussion. that meeting is still going on right now. in the trilateral meeting, there was a long and productive discussion on a range of issues. president abbas and prime minister netanyahu expressed their intent to approach these negotiations in good faith and with a seriousness of purpose. they also agreed that for these negotiations to succeed, they must be kept private and treated

with the utmost sensitivity. so what i and they are able to disclose to you today in the future will be limited. but i will now describe some of the key items that were addressed in the trilateral meeting. both prime minister netanyahu and president abbas condemned all forms of violence that target innocent civilians and pledged to work together to maintain security. they reiterated their common goal of two states for to people's, and to a solution to the conflict that resolve all issues, ends all claims, and establishes a viable state of palestine alongside a secure state israel. president abbas and prime

minister netanyahu agreed that these negotiations can be completed within one year and that the name of the negotiations is resolve all court issues. the parties agreed that a logical next step would be to begin working on achieving a framework agreement for permanent status. the purpose of a framework agreement would be to establish the fundamental compromises necessary to enable them to flesh out and complete a comprehensive treaty that will end the conflict and establish a lasting peace between israel and the palestinians. the parties agreed that in their actions and statements they will work to create an atmosphere of trust that will be conducive to reaching a final agreement.

they agreed to meet again on september 14 and 15 in the region and roughly two weeks thereafter. every two weeks thereafter. of course, continued interactions at other levels between the parties and also yet others involving the united states will take place between those meetings. in fact, a preference -- preparatory trilateral meeting in order to plan for that second meeting in the reading has already begun in another location in this building and will continue here and in the region between now and september 14 as is necessary. as both president obama and secretary of state clinton have said, the united states pledges its full support to the parties

in these talks. we will be an active and sustained partner to route. we will -- throughout. we will put our full weight behind these negotiations and will stand by the parties as they make the decisions necessary to is you or -- to secure a better future. as we saw this week, there are those who will use violence to derail peace talks. there will be difficult days and many obstacles along the way. we recognize that this is not an easy task. but as the president told the leaders, we expect to continue until our job is complete and successful. with that, i will be pleased to take some of your questions. >> i would like to know what was the personal relationship?

it seemed like they were distant. did they interact or develop a bond together? >> the relationship was cordial. as you know, these men have known each other for a long time. this is not the first meeting between them. they are not in any way strangers, politically or personally. >> thank you. obama yesterday talked about some progress when asked, and i appreciate the fact that you do not want to diebold the details. today the prime minister talked about the jewishness of the state.

the you think these issues -- since they launched the negotiations today, the think this could be an issue that could be [unintelligible] for the peace process. >> thank you, i believe very strongly, deeply and personally that this conflict can be resolved and these negotiations can produce a final agreement that enables the at establishment of a palestinian state and peace and security for all peoples. secondly, it is of course self- evident that the reason for a negotiant it is that there are differences, the differences are many, they are deep, they are serious, and it will take

serious good-faith negotiations, sincerity on both sides, and willingness to make difficult concessions on both sides if that agreement is to be reached. but i do not think that any human problem can be solved if one begins by reviewing the problems as insurmountable, as suggesting that the mountains are too high and the rivers are too wide, so let's not undertake a journey. there has to be a sincerity and a seriousness of purpose combined with a realistic appraisal of the difficulties, but a determination to overcome them. i believe that exists. i believe these two leaders,

president abbas and prime minister netanyahu, are committed to doing what it takes to achieve the right result. >> you remember from your life on capitol hill the phrase whenever a tough addition was going on, nothing is agreed to until everything is agreed to. will that be the approach for this process, and will you be reluctant to talk about anything that is agreed upon until everything is agreed upon? the second question is discuss the framework. is the deadline for the pri -- for the framework one of the year, or much earlier and a one- year still governs the entire solution to all remaining issues? >> in terms of process, that and other questions will be resolved by the party's. you cannot separate process from

substance in these discussions. there is an interaction that affects both, and we have made it clear that these issues are to be determined by the parties. we have had extensive discussions with them on that on those issues, and those will continue. our goal is to resolve all of the core issues within one year. and the parties themselves have suggested and agreed that the logical way to proceed to tackle them is to try to reach a framework agreement first. and as i said -- and i think this ought to meet clear because it is -- there has been a good bit of misunderstanding or not a full meeting of minds publicly regarding a framework agreement.

a framework agreement is not an interim agreement. it is more detailed than a declaration of principles, but it is less than a full-fledged treaty. its purpose is to establish the compromises necessary to enable the parties to then fleshed out and complete a comprehensive agreement that will end the conflict and establish a lasting peace. >> thank you. you mentioned the number of issues talked about talks -- today, but can you mentioned that settlement was among them, and the plan to be in the region for the talks that will take place on the 14th and 15th? you said the u.s. will be a part of the talks. you plan to be there? can you tell us where they are going to be? >> as i said at the outset, what

i will be able to disclose to you and the parties will disclose will be limited, and so you have given me the first opportunity to invoke the principle with respect to the first part of your question, for which i thank you. [laughter] secondly, but secretary clinton and i will be at the meeting in the region on september 14 and 15, and one of the subjects now being discussed in the trilateral preparatory meeting that is ongoing in another room in this building, to which i must go in a few moments, is that subject. a determination has not yet been made. that will be made i believe in the near future well in advance of the meeting. >> abc news.

i would like to take another crack addict. i understand and appreciate that you cannot get into specifics, but i'm curious whether you could say anything about the scope of today's talks, whether they involve any substantive discussions on any of the court issues or whether this is strictly to lay out a plan for the coming year. thank you. >> as i mentioned in my response to major's questions, i cannot think one can neatly characterized process and substance as though they are two separate things in these matters. they do interact and relate to. you cannot discuss a process issue in any meaningful way without some relations to the substance that is being to be discussed -- that is ready to be discussed.

that gives me a chance to say for the second time that i will not be able to get into the substance. but there were discussions that text on the subject of substance, although i do not want to suggest that the meeting was such that there was a detailed and extended discussion or debate on a specific substantive issue. >> netanyahu talked-about recognizing a palestinian claim that the -- is that something that you have noticed? is that something that the americans have been encouraging? >> we have encouraged the party

ies to be par y' positive in our outlooks, other words, and their actions. any realistic appraisal of the situation, including the recent history, by which remain the last two decades, makes clear that there are very serious differences between the parties. there are many difficulties that lie ahead. that is in terms of the substance of the issues, the impact on their domestic politics, the needs and interests of their societies. we have not, of course, attempted to prescribe what they

can or should say about any issue. these are independent and extremely able leaders representing the interest of their societies. what we have sought to convey in a new role conversations that i have had -- in innumerable conversations that i have had with both leaders is president obama's conviction that, despite all of the difficulties, near term, long term political substantive, personal and otherwise, the paramount goal of making the lives of their citizens more safe, more secure, more prosperous, more full can best be achieved by a meaningful and lasting peace between the

parties and in the region. the alternative to that poses difficulties and dangers far greater to the individuals, to the leaders, to their societies than those risks than they run in an effort to reach an agreement that brings about their lasting peace. any realistic evaluation of the self-interest of the people of israel and the palace -- and the palestinian people must conclude that they are far better off living side-by-side as in two states in peace and security than in a continuation of the current situation. >> prime minister netanyahu

mentioned iran this morning. would that not make things more difficult to close the gap between the two parties? >> in every aspect of him a lot, including your personal life and mine, the world is much different today than it was 10 years ago and vastly different than it was 20 years ago. that is certainly true of the middle east. it is an area of rapid change, of many conflicting currents that historians and analysts have described far better than i could in any change we have here. obviously, the actions and policies of the current government of iran have an

effect in the region and in the wider world. they influence what is occurring here. in my judgment, they add another argument to those which i have already made and that many others have made as to why this conflict should be resolved. it is in the interest of the people involved. in this respect, the worst comprehensive peace is direct. when president obama announced my appointment, he specifically identified comprehensive peace as the objective of u.s. policy in the region. israel and the palestinians, israel and syria, israel and lebanon, israel at peace with all of its neighbors in normal

relations. obviously, one of the factors that makes that desirable, in my judgment, necessary for all of these parties is, in part, reactions and policies that have been taken. yes, it is a factor. even if it did not exist, there would be a compelling reason for peace between israelis and palestinians. but that is an additional factor. >> peace negotiations between the parties have taken place several times in the past. what is secretary clinton doing differently than her predecessors, including president clinton? >> although my comment on that

is not constrained by the agreement which i've earlier described, there are other constraining factors which come into play. [laughter] since i was not a part of the immediately preceding administration -- although i did serve at the request of president clinton as chairman of an international commission in 2000-2001 following the eruption of the second fought, -- second fata, first, we cannot be deterred by the fact that

negotiations did not succeed. it must continue with steny prior efforts of failure -- it must continue despite prior efforts. with respect to past efforts, we think that the best approach is to carefully review them as we have done and to try to draw the best lessons out of each one, not be bound by any particular practice or process or procedure, and always try to keep in mind the dynamic changes in the region that have occurred in what is, in historical terms, a very short time. our view is that this is an

effort that will try to learn from the lessons of the past, take the best and bring them forward, but not be bound by any level or category or previous process. everything should be judged on the basis of what it will do to a dance -- to advance and achieve the goal of peace in the region. one obvious difference is that president obama is the only president in recent times, to my knowledge, to have established this as a high priority. immediately upon taking office, to have acted immediately at that time -- there have been very well written books and it

is clear in a couple of instances that time ran out. indeed, the authors of several of these books used exactly those words to describe it -- they ran out of time in the end. this president, i believe, will succeed. as he said yesterday, neither success or failure is predetermined or guaranteed. but it will not be because time ran out at the end. that is a vast difference. i have a high opinion of the men and women who served in these tasks in the past. i know most of them personally. i do not think you can attribute inability to achieve a result to their individual or collective feelings. they are the product of the difficulty and what many regard

the impact ability of the problems and issues -- the impractability of the problems and issues. the most obvious difficulties that lie ahead for both sides comes if they do not reach agreements. you have to remember that these leaders must weigh two things. the difficulties they face in getting the agreement and the difficulties they will face if they do not get an agreement. we believe it is a very powerful argument, a few subject these careful and reasoned analysis,

the difficulties will be much greater and have a much more profound impact on their societies. thank you all very much. it has been a pleasure to see you. i look forward to reporting to you on a regular basis. >> search mid-east peace and you get more than 1700 programs and 8000 transcripts. interviews, panels, and forums come all the way up to this

week's peace talks. all free online. it is washington and the world your way. >> federal reserve chairman ben bernanke testified before the financial crisis inquiry commission about the idea of institutions that are thought to be too big to fail. the head of the federal deposit insurance corp., sheila bair. a form on the te -- forum on the tea party movement. tomorrow morning, we will look at issues facing u.s. cities. president of the national league of cities. he is the mayor of riverside, california. lara brown will talk about her book. our series on politics concludes with the effective polling on elections. our guest is alan abramowitz. "washington journal" is wants on

7:00 a.m. every day. >> there is nothing about finance that is like rocket science. that is the frustrating thing. you think about ponzi schemes. the biggest ponzi scheme is telling someone who has worked really hard to earn a book that they are not smart enough to understand how that is going to be invested. >> in 2007, meredith whitney was the first to predict losses for citigroup. she is our guest sunday night. the c-span network. we provide coverage of politics, public affairs, and history. it is available for you on television, on-line. find our content through the video library. we take c-span on the road.

bringing our resources to your community. it is washington your way. the c-span networks. available in more than 100 million homes. greeted by cable. provided as a public service. ben bernanke said for regulators need to solve firms that are thought to be too big to fail. he spoke before the financial crisis commission. the commission is a bipartisan panel created by congress and due to report its findings this december. this is 2 1/2 hours.

good morning and welcome to the hearing. this is our second day. examining the issue of financial institutions. has it become too big, too important, to systemic to fail? ed at two we look tha case studies and this morning, we will be hearing from the chairman of the federal reserve as well as the chair of the fdic, ms. sheila bair. welcome, mr. chairman. thank you for joining us. i might note that this is the second time you have come before this commission. first in our offices for a private session when we were first convened. as we began our work almost a year ago. today, in what will be our final hearing in washington, d.c., although after today, we will go across the country to a number of communities in california,

nevada, and florida to hold hearings in communities that are still gripped by high unemployment and high foreclosure rates. we will be going to those communities to see how the seeds of this crisis were sown on the ground and what the consequences are. as we have done with all witnesses, we will ask you to stand so i can swear you in. if you would stand and raise your right hand. do you solemnly swear or affirm under penalty of perjury that the testimony you're about to provide the commission will be the truth, the whole truth, and nothing but the truth to the best of your knowledge? thank you. thank you for your extensive written testimony. your extensive written testimony. and this morning, well like to ask you to speak to us orally, and take up to 10 minutes this morning to give your opening remarks, at which point, upon

conclusion of your opening remarks, we'll move to questions from commissioners. so mr. chairman, the floor is yours. >> thank you, mr. chairman. i won't take the full 10 minutes and i'd like to say that we'll be submitting additional answers to your questions very shortly. chairman angelides, vice chairman thomas an other members of the commission, you're charged to examine the causes of the recent financial and economic crisis are indeed important. only by understanding the factors that led to and amplified the crisis can we hope to guard against repetition. so-called too big to fail financial institution were both the source, though by no means the only source, of the crisis and among the primary impediment of policymakers to contain it. in my view, the too big to fail view can only be viewed in the broader context of the financial crisis itself. in my full written testimony, i provided an overview of the factors underlying the crisis, as well as some of the public officials management of the crisis. in understanding the causes of

the crisis, it's essential to distinguish between triggers, the particular events or factors that touched off the crisis, and vulnerabilities, the structural weaknesss in the financial system and in regulation and supervision that propagated and greatly amplified the initial shocks. although a number of developments help to trigger the crisis, the most prominent was the prospect of significant losses of subprime mortgage loans that became apparent shortly after house prices began to decline. while potential subprime losses were large in absolute terms, judged in relation to global financial markets, they were not large enough to accounts for the magnitude of the crisis on their own. instead, the system's preexisting vulnerabilities, together with gaps in the government's crisis response tool kit are the primary explanation of why the crisis has had devastating effects on the global financial system and the broader economy. let me give you an you will striation of how as a result earlies in the financial system greatly increase the effects of the triggers of the crisis.

in the years before the crisis, a system of so-called shadow banks, financial entities other than regulated depository institutions had come to play a major role in global finance. as it grew, the shadow banking system, including certain types of special purpose vehicles, such as those financed by asset backed commercial paper and some investment banks, have become dependent on short-term wholesale funding. such reliance on short-term uninsured funds made shadow banks subject to runs, much like commercial banks had been prior to the creation of deposit insurance. when problems in the subprime mortgage market an other credit markets became known, the providers of short-term funding ran from the shadow banks, disrupting short-term money markets. thus, the vulnerability in this case, the excessive dependence of many financial institutions on unstable short-term fund, greatly amplified the effects of the trigger in this case, the prospective losses of the subprime mortgages. among of the consequences of the

instability was sharp declines and high volatility in asset prices, widespread hoarding of liquidity by financial institutions and associated reductions in the availability of credit to support economic activity. many of the key vulnerabilities of the financial system were the product of private sector arrangements, including, as just noted, overdependence of many financial institutions on unstable short-term fund, poor risk management, excessive leverage of some households and firms, misuse of certain types of derivative instruments, mismanagement of the mortgage securitization process an other problems. but important vulnerabilities also existed in the public sector, both in the united states and in other countries. these vulnerabilities including both gaps in the the statutory framework and flaws in the performance of regulators and supervisors. important examples of statutory gaps were the absence of effective authority to regular lay and supervise some important types of shadow banks, such as special purpose vehicles and

broker dealer holding companies. the lack of authority or responsibility to take actions to limit systemic risks and the absence of a legal framework under which failing systematically critical, non-bank financial firms could be resolved in an orderly way. where appropriate authorities existed, financial regulators an supervisors, both in the united states and abroad, not always used them effectively. for example, bank supervisors in many cases did not do enough to force financial institutions to strengthen their internal risk management systems and to curtail risky practices, and bank capital and liquidity standards were insufficiently stringent. the resents financial reform legislation addresses many of the statutory gaps i have mentioned, and the federal reserve and other agencies are taking strong steps to tighten the regulation of financial institutions, to give regulation and supervision a more systemic and multidiscipline orientation and to make supervision more effective. many of the vulnerabilities underlying the crisis were linked to the existence of so-called too big to fail firms.

those whose size, interconnectivity and functions were such that their unspeck failure was likely to severely damage the financial system and the economy. because of the grave risks presented, too big to fail firm filed for bankruptcy protection, in the short run, governments have strong incentives to prevent such events from occurring. hence, too big to fail. however, in the longer term, the existence of too big to fail firms creates severe moral hazard problems, which can lead to the buildup of risk and future financial instability, while complicating the resolution of financial crises. the existence of such firms also creates an uneven playing field between the largest firms and their smaller competitors. it is critical that the too big to fail problem be solved. an important components of the solution contained in the resents financial reform bill is the development of a resolution framework that allows the government to resolve a failing systematically important, non-bank financial firm in an orderly way, while imposing

appropriate losses on creditors, protecting taxpayers, and limiting risks to the broader financial system. tougher regulation and supervision of systematically important firms and steps to increase the resilience of the financial system are also important if we are to bring a decisive end to too big to fail. the findings of this commission will help us better understand the causes of the crisis, which in turn, should increase our ability to avoid future crises and to mitigate the effects of crises that should occur. we should not imagine though that it is possible to prevent all crises. a growing, dynamic economy requires a financial system that effectively allocates credit to households and business. the provision of credit inevitably involves risk taking. to achieve both sustained growth and stability, we must provide a framework which promotes the appropriate mix of prudence, risk taking, and innovation in hour financial system. thank you, mr. chairman. >> thank you very much, mr. chairman.

we will now begin with questions. i will start the questioning and we'll go to vice chairman thomas and then to the balance of the members. so i'd like to talk to you for a few minutes about the runup to the crisis, because i believe, you know, a lot of the focus is always on did the government do the right thing in the grips of the crisis, the real question for me has always been, how do we get in the position where we face such draconian choices an one of the things that struck me as we reviewed our case studies is the failure of regulator supervisors to identify and contain systemic risk in too big to fail institutions before the crisis hit. yesterday, we looked at wachovia, where assets grew from $250 billion to $7,802,000,000,000 by -- $782 billion and an aggressive growth rate of 17%, tangible asset to tangible equity ratio of 23-1. the acquisition of a big book of

pay option arms from golden west, which in and of itself was three times tier one capital. but no progression by the fed or the occ of the systemic risk, in fact, no downgrading of the institution until july of 2008. similar fact pattern at lehman, even though we realized the fedoras not the prudential supervisor, but again i'm talking in a larger sense, very aggressive growth, leverage of 39-1, let me just ask you, why such a bigamist and i want to put this in context, that some of your folks who have spoken to us here, like mr. alvarez and mr. cole, whom we interviewed, talked about how the fact is, well, gee, we had, and i think it was maybe mr. cole who used the word myopic, safety and soundness, but shouldn't have systemic risks been part of a safety and soundness regime even in the 2000 period? was this a substantial miss, how

fundamental was the failure of proper supervision to the metastasizing of this problem? >> mr. chairman, first of all, it should be recognized that large complex international financial institutions do have an appropriate role. and the fact that you were seeing growth and complexification of these institutions in a world of financial innovation, international capital flows, financial supermarkets and a whole variety of other innovations in itself should not be surprising. that was happening not only in the united states but happening globally, so there clearly was a reason for the growth and for the more complex institutions. now, that, said, it's certainly true that the system did not sufficiently anticipate the systemic risk associated with these institutions. that was frankly part my due to the regulatory structure that was given to us by congress, as you had mentioned, or charge was

to focus on the safety and soundness of individual institutions. there was no provision, no authority to address systemic risk in an institution. in fact, when the fannie and freddie law was redone and there was additional regulation put on fannie and freddie, the congress explicitly said you are not allowed to consider systemic risks when you're looking at the safety and soundness of this institution and furthermore, there was no -- no, that was part of the fannie and freddie's -- of the law that created the fhfa, the new institution. but -- and furthermore, there was no -- there was no collective assignment as there is under the more recent reform legislation, to look for systemic risks. many of the risks that occur obviously are interactions of the size and complexity of individual firms, but features

of the entire system. they are emergent properties if you will of the overall system. having said all that, i must also agree, that supervisors in the united states and around the world underestimated the risks associated for example, with insufficientlinsufficient liqui. a bank run essentially. we underestimated the stents to which risk remained concentrated within important financial firms, and so i'm not claiming that we found all those problems, but there was a combination of the structure of the system, the underlying trends toward greater and more complex firms, together with some mistakes and shortcomings on the part of regulators. [inaudible] >> thank you so much. it's early. it's been a long -- it's been a long journey for in commission and this is not a matter of political ideology, but there does seem to be within the financial markets, there was it

appears to be a greater and greater reliance also on self-regulation. mr. alvarez in an interview he did with our staff, i believe in march, talked about the deregulatory environment in which policy decisions were made and again, without regard to party. i'm gogans say that -- going to say that very squarely here. mr. cole talks about recognizing some of the problems in the institutions and the ride up the rollercoaster but the push back from financial institutions, so how much of this was also a function of a shift away from an aggressive regulatory regime to frankly, just a common view that we should be more reliant on self-regulation, internal risk management by the institutions and replacements of regulation? >> well, i think there's some truth to that. it was -- there was some change in i think in overall velocity, as firms became more complicated, there was a greater and greater understanding that regulators could not replicate all the risk assessments that the firms themselves could do,

and we had to rely more on their own assessments or instead, instead of looking at the risks themselves, making sure they had good systems in place and they were taking appropriate steps to address those risks, so that's certainly a problem and it was exacerbated i think by the fact that there's always i am police italian international competition before the crisis, one of our main concerns was london and tokyo, where they, you know -- were they taking away the financial industry from the u.s. and was excessive regulation doing that, so those are some of the concerns. that being said, i think that innovation in of the financial system, partly to avoid regulation, but also in part, to respond to the legitimate changes in the economy, i refer to the shadow banking system a moment ago. the development of new types of financial institutions off-balance sheet vehicles, non-bank mortgage lenders, much bigger investment banking activities and so on, our bank regulatory system was designed

for a bank centric financial system and that's where it came from and as always these non-bank activities grew, we were not -- we, the country, were not sufficiently proactive in establishing a regulatory framework to encompass all of those aspects. >> all right. thank you. but it does seem to be particularly for entrepreneurering into an era of larger and larger banks that if we're going to have banks that are too big to fail, it would mrs. seem to me that we need regulators that are too tough to fold. this is going to be a particularly challenging environment, with a set of even larger banks, fewer of them. would you agree with that, that the challenge going forward is even more dramatic? >> i think it's very, very important. as i said before, the most important lesson of this crisis is we have to end too big to fail and i believe that we, in a much different way than we did before the crisis, we now have the tools to address that. in particular, tougher regulation and oversight will reduce the risks. the existence of a resolution regime will increase market

discipline, because creditors will know that they can lose money and strengthening the resilience of the financial system itself will reduce its incentive of the government to i want convenient in these situations. my projection is even without direct intervention by the government, over time, we'll see some breakups and some reduction if size an complexity of some of these terms as they respond to the in 10 cyst created by -- incentives created by market pressures and regulatory pressures as well. >> so, our staff prepared for us what i thought was an excellent -- all the information you already know, by virtue of being chairman of the fed and your background, but it was striking that our staff did for us, and it's posted on our web site, essentially a history of too big to fail, also, governmental rescues from franklin national to continental illinois through the multiple rescues in 2008 and as i look at it, you almost can take the view that wall street seems to believe that a financial sucker is born every crisis, and so i think one of the biggest

questions that americans have is how do we break the cycle? what is the singlemost important thing that should have been done and can be done in the future to break the cycle? the singlemost important policy action that we can take. >> there has to be a credible way to let firms fail, in fact, require that they nail. i think it's striking that the new rules do not permit discretion. they do not allow so-called open bank assistance, which allows the government to assist a firm to continue to exist, rather, what it does is provide a system for trying to take a firm into receivership in a way that does minimal damage to the system. it's not going to be easy. let me just be clear. this is not going to be easy to implement, because these are large, complex firms, with multinational presence. >> and significant power. >> and significant power. but is -- a very important step to take away the discretion. if i might have just cite the examples of the law passed in the early 1990's, which created

a set of well specified triggers under which the fdic has to come in and close a bank, except under extreme circumstances, systemic risk exception. there is no systemic risk exception for the resolution regime in the dodd-frank bill. that has worked very well, and the analogy to using that, applying that to large firms, i think it's very important, so i can -- i could hardly agree with you more, mr. chairman, that this was a catastrophe, and it's bad in the long rupp, as well as in the crisis, and we must address it. >> all right. let me talk for a moment about failed institutions. as you know, we had mr. fuld here from lehman yesterday, mr. baxter from the federal reserve bank of new york. you stated on many occasions that the failure of lehman had consequences. in the role as commissioner doing our level best to understand the history of this crisis, we're trying to -- at least i am, trying to unfurl the

set of decisions, the why's, the wherefores. when you first testified to congress after the failure of leave man, you had essentially said in your testimony and i'm shortening this up that lehman was not rescued, essentially because the market, the participants had had time to prepare in the wake of market developments. and i say this as i said yesterday, it seems to me that the decision to allow lehman to nail was pa conscious policy decision, and -- to fail was a conscious policy decision and not implying people said let them just go down, but like any other policymakers, you were weighing a whole set of factors. now, since early on, it seems as though the fed and other officials have indicated that it was solely due to a lack of legal authority, the inability to make the loan under 133, the lack of sufficient collateral, but when i at least look at the chronology, it seems to me you were trying to deal with a whole

set of complex factors. we released yesterday a chronology of different events along the way and it seems to me that, you know, there was serious consideration of financial assistance, the fed stepping into the shoes of the clearing banks, if that was necessary, you know, mr. did you doily, for example, i think in july proposed a maden lane type of solution. mr. geithner told the fsa as late as a few days before the failure that government system was possible and as late as the last few days, there's a federal reserve board in new york, of new york, document i think mr. parkinson circulates, we should find a maximum number of how much we are willing to finance before the meeting starts, but not divulge our willingness to do so to the consortium. in terms of any liquidity, support should be long enough to guard against a fire sale, but a

short enough fuse to encourage a buyer of lehman assets to come forward, two months to two years in duration. question mark. lehman seems to be bigger than bear. there certainly seem to be political considerations and i don't necessarily mean at the fed, but among treasury, white house, which is legitimate. people are trying to weigh the mood of the country, how policy makers are going to view this. there's an awareness of impacts, larger triparty book than bear. a bigger and more complex institution to unwind. i don't see any documents or discussion along the wave about legal bars or government analysis of a shortage of collateral and i see mr. alvarez's position in march of 2009, saying the fed has wide latitude in terms of how it defines collateral. my real question for you, what was the mix of policy considerations? i understand because i've been in transactions on the private side and the public side, that there will shall legal barriers,

obstacles that have to be respected, but it doesn't look as though that cut this discussion off. what were the biggest considerations, would you have saved lehman, if you had the legal authority, but in rolling up to that decision, trying to determine were they too big to fail, not too big to fail, you've already said that you thought it had significant disasterrous consequences, what were the things you were trying to weigh, the decision-making factors. >> i can only speak for myself. i don't know everybody's review on that. first of all, there was, of course, we were trying to arrange a private takeover, over the weekend, and we wanted that to be done on the best possible terms that we could and for that reason, there was some benefit i think in the week prior to lehman to keep our hands, you know, a little bit up to the vest in terms of what we were willing and able to do, so there was some of that going on in the week prior to the lehman weekend. that being said, let me just state this as unequivocally as i

can, before i came to the fed chairmanship and i studied the financial crisis, and this is my bread and butter, and i believe deeply, that if lehman was allowed to fail or did fail, that the consequences to the u.s. financial system and the u.s. economy would be catastrophic, and i never at any time waivered in my view that we should do absolutely everything possible to prevent the failure of lehman. now, on sunday night of that weekend, what was told to me was that, and i have every reason to believe, was that there was a run preceding on lehman, that is, people were essentially demanding liquidity from lehman, lehman did not have enough collateral to allow the fed to lend it enough to meet that run, therefore, if we lent the money to lehman, all that would happen would be the run would succeed,

the firm would fame, and not only would we be unsuccessful, but we would have saddled the taxpayer with tens of billions of dollars of losses. so it was both a legal consideration, but also a practical consideration. legally speaking, we are not allowed to lend without a reasonable expectation of repayment. the loan has to be secured to the satisfaction of the reserve bank. remember, this is before t.a.r.p. we had no ability to inject capital or make guarantees. the unanimous opinion that i was told and i heard from both the lawyers and from the leadership of the federal reserve bank of morning, lehman did not have sufficient collateral to borrow enough to save itself, and therefore, any attempt to lend to lehman within the law would be futile and only result in a loss of cash. in some cases, you can take the going concern value of the firm into consideration, but in this case, lehman was under a run, its going concern value was

melting away, because its customers, counterparties, employees and so on were not going to be sticking with this firm, so i believed as of sunday night, it wasn't just a question of legality, it was a question of whether we could conceivably do that would prevent the failure of the firm and therefore, it was with great reluctance and sadness that i conceded that there was no other option, there was never any -- there was never any discussion which says, here's how we can save lehman, should we do it or not. we never had a discussion like that. the discussion was, there is no way, and that was my belief and that's how i proceeded, because as i said, if i could have done anything to save it, i would have saved it. now you asked appropriately about the -- >> can i ask one question on that. you said you represented your own views. there were differential views expressed, i've seen in the e-mails, concern about the politics, bear has been bailed out, the gsc's, there seems to be some political reluctance, mr. wilkinson is writing e-mails, can't stomach a

bailout. >> well, it's certainly understandable that people would have those concerns, but i must say in my own case and as far as i know, in the cases of the other principals, the primary consideration was the knowledge that the failure of lehman would have catastrophic consequences. met me just say one word about the testimony you referred to, which has gotten -- has supported this myth that we did have a way of saving lehman. this is my own fault in a sense, but the reason we didn't make the statement in that testimony, which was only a few days after the failure of lehman, that we were unable to save it, was because it was a judgment at that moment, with the system in tremendous stress and with other financial institutions, under threat of run, or panic, that making that statement might have even reduced confidence further and led to further pressure. that being said, i regret not being more straightforward there, because clearly, it has

supported the mistaken impression that in fact, we could have done something. we could not have done anything. >> one last question on the subject. that is a loan was made under the pdcf to the broker dealer i believe in the amount -- i guess authorized $50 billion, but i think daily amounts were 29, $30 billion and of i don't the numbers with me exactly. you were able to do that because -- >> because they had sufficient collateral to support the loan. >> that was not available on the night before at the holding company level? >> correct. >> because the holding company had a capital hold in your judgment? >> i believe it had a capital hold, but in any case, the calculations were that the liquidity demands on the holding company were much greater than the collateral they had available to meet the demands and moreover, by the way, we didn't do anything to prevent the broke are dealer from lending to his own holding company and it didn't seem to decide that was a smart thing to do either. >> of course at that point they

had filed bankruptcy and i'm not going to take your time with yesterday's dialogue with mr. baxter about what i preferred to as the smoking letter about whether in fact, the holding company had the ability sunny. we'll tip to look at that matter. matter. and what transpired. >> i can only tell you what i knew at the time and what i knew at the time and what i was informed and what i believed was that there was no capacity for them to borrow sufficiently, have enough collateral to borrow sufficiently to meet their obligations. >> was that based on an analysis or the private consortium's analysis. >> why that was based on analysis at the federal reserve bank of new york, going on through the week and before that we had done a lot of analysis based on our presence atley man -- at lehman during the summer. >> one final question, i'm exhausting my time, very quickly, i want to ask you, as we look at the genesis of this crisis, it's hard not to look at the actions of the fed prefer and i know mr. thompson is going to want to talk about this all. when you look at the opportunity to regulate subprime lending,

rules were adopted in 2001 that ended up covering only 1% of the loans, when you look at the referral of unfair and deceptive lending practices to justice, only two institutions, i think the desert community bank in victorville california and the first american bank in illinois, only two referrals in six years, a decision not to examine non-bank subsidiaries, was this a very significant failure in your looking back in retrofit fro expect. >> i think it was indeed, a most severe failure of the fed in this particular episode. >> i think mr. thompson will want to ask some more about that. i'm defer the rest of my questions if i have any, to mr. thomas. thank you very much, mr. chairman. >> thank you, mr. chairman. and thank you, mr. chairman. nice to see you again. let me say first of all, for those of us who have been around for a while, some folks might move us in the category of

mr. senator, having been around forever. and you look at the political situation, just in terms of coordination and ability to move quickly. which is always difficult in a political body. in the fall -- well, decembe december 2007, fall of 2008, spring of 2009 and of course now today, historically, when you look back, that actually was a presidential election period. there was a change in government and for those of us who have been actually involved in these kinds of processes, i want to thank you, and i want to thank the others who were involved, because it took, in my opinion, a degree of aggressiveness that had you not been bold enough to

carry out, circumstances might have been significantly different, so thank you. after the fact, you get people who may have been pretty upset. some behind closed doors, some in open doors, now beginning to take a look at really where we were. and situations that would have occurred. obviously, you talk about gaps, the reason we talked about gaps is because we now know there were gaps. before we knew they were gaps, it's always hard to find the gap. one of my worries now becoming more acquainted with the complexity, the failure of transparency, what people thought was adequate capital, carrying out various kinds of behaviors and the complexity that is now present, not just nationally, but internationally, one of the concerns i have is while -- well, your final statement about obvious needs in

terms of the structure that we have on a flexibility of movement, that when you try to look at dealing with too big to fail and so we aren't going to let that happen again and you set up a structure, is there any concern about some of these structures might be too complex to unravel in a time period that is meaningful, given the circumstances? because at some point, what high heard from virtually everyone, we just heard the testimony yesterday some of the derivatives products, they're still trying to unwind them in the lehman bankruptcy. what concerns can you share with us in terms of -- i mean, i often think, you know, you've got the cartoon of the child who is going to go out in the snow, so the mother puts on one layer,

two layers, three layers and it finally then is allowed to go outside and play, and it can barely move getting outside. you can set up a structure to make sure that it doesn't happen, but how do you keep the flexibility to allow this system to function? where are we in terms of your concerns, dodd-frank legislation, providing some additional tools, comfort level and now understanding better and more importantly, if we are now not going to have these crisis interventions when we do fail, unwinding structures in a reasonable way. >> that's an absolutely central question. of course, as you know, chairman bair has written testimony which addresses this issue in some detail. >> as we say, she's next. >> she's next on the program, i understand. it's a very difficult problem.

certainly, the kind of firms we're talking about are much more complicated than the small and medium sized banks, which are the typical companies that are unwound through the fdicia process, so this is not at all an easy process, however, i think we'll be much better off, if you think about -- one thing i feel people don't always appreciate is we try to do these very complex operations, you know, within hours, within a weekend, and certainly we'll be much better off if we have extended amount of time to understand and study and prepare and make plans, and that is an important part of what the fdic's new division on complex firms is about. they will be aided, as will we, at the federal reserve, by living wills, that is, by a required document that firms will provide, which will explain how they would be wound down and if those living wills are not

satisfactory, we have the authority to require them to simplify their legal and organizational structure as necessary to make it feasible, so it's going to be very difficult, but certainly, we'll be much better placed than we were prior to this crisis. i think the one area where it's going to take a lot of effort is the international element. because these firms, one of the banks that we supervise has offices in 109 countries, each one with its own bankruptcy code and its own rules and so on beings an we're going to need to develop sort of the moral equivalent of tax treaties with other jurisdictions, whereby we have rough agreements on how we would cooperate and work together, so unwind a firm, and that will be very challenging, but it's something that's currently being heavily investigated by international bodies like the financial stability board and i any it should be a top priority. >> and where are we in terms of those discussions, because that was definitely one of the concerns that i had.

we could resolve our problems and if we can't get an international agreement, given the complexity and the multinational nature of today's financial structure, and of course, the farther you get away from the cliff, the less you want to kind of make the sacrifices that allow for that international stability. what's your comfort level and where we're going on that. >> the fdic is well advanced in developing rules to explain how they will invoke these powers an we are working with the fdic to develop more knowledge to go about unwinding u.s. firms. as you agreed, the international aspect is very difficult, but there is a very concerted effort, as i mentioned, the financial stability board and the bank's international settlement and other international bodies are looking at this very seriously. i think what we will have to do is work primarily with the

principal countries although this bank is in 109 countries, there are four or five countries, which are the most important that we have to work with, which has the largest banks and bank presence, so it's going to require some, again, some agreements, some mou's, some work together, some ideas about how to divide assets, how to reconcile different bankruptcy codes and the like, so it's a lot of work to be done. and i -- you know, i think we have a way to go still, but obviously, we're very focused on doing that and we have a lot of cooperation and goodwill from our international partners. >> and mr. chairman, you indicated, i think the phrase was, the regulations given to us by congress, you know, and we always looked for the ability to structure legislation with the flexibility under regulation, did not put any to a statutory straitjacket, but i had some

concerns yesterday in testimony. when you look at that period in late september-early october, in attempting to deal with wachovia, and in the minutes of the fdic discussions, they take the very extraordinary step of accepting the concept of hopefully no dollar exposure, but responsibility for backup, on the city wachovia structure. that's put to bed. and then literally, the very next day, i.r.s. issues 20883, fundamentally changing a two-decade old tax code provision and you may recall some of us from the article i part of government being fairly sensitive, because there's a

difference between needed and desirable. and it concerns me very much that whoever was meeting came up with an idea that could solve the problem. but didn't fully appreciate the consequences of inventing solutions when you're charged with not carrying out activities and the argument, we weren't given the power by congress, but where you came up with an idea that could be inventive, you go ahead and do it. the real difficulty for me in the long run, in these kinds of situations, is whether the executive branch is a demand center, or whether it's a command center, and clearly, there are times when it has to be a command center, both domestically and internationally, but more often, the argument that we had to be a command center is used to do what you want to do, rather than

not. did you have any behind the scenes knowledge of i.r.s. and treasury deciding to create what we call in the business, a rifle shot? in terms of picking up losses of a company that they could arequire, which this kind of fundamentally violated a portion of the tax code as i said that had been honored for a couple of decades, which actually changed the result of what happened to wachovia in finding a home, in my opinion. and others may argue. any reaction to what i just said? >> i have all i can say is, i just don't know the facts monday that, but i can say that i have no knowledge, i have no inside knowledge or any other kind of knowledge of this fact before it occurred. from my perspective, putting aside the very important procedural and legal issues that you raised, it was

inconsequencial, because one way or another, wachovia was going to get protected and that was the thing i was concerned about. i did not advocate or get involved in the the tax decision. >> well, our concern is that in a crisis, which we went through, necessity can be the mother of invention, but you better come up with a solution, coming out the other end, that doesn't provide you or embolden you with the opportunity to do what happened again. i know, some of my colleagues got pretty frightened when they were presented with the option that you must pass what's on this piece of paper, before tomorrow morning or the world, as you know it, is going to end. you bet away with that once, and i'm hopeful that as we continue to move forward, you spend a lot of time consulting with those who actually believe they have some role to play, not after the fact. but during it. is there a comfort level now in

terms of your ability to communicate with the legislative branch, that perhaps you couldn't do in that crunch time frame? >> yes, certainly with the benefit of time, clearly, these activities were not things that i wanted to do. the fed presever took an enormous amount of heat for them and came under a lot of pressure politically and legislative because of those actions, so i would much rather would not have had to do them and i'm very happy to see that we're moving towards a system where there is a well designed framework for addressing these problems and i hope that we can mask it workable so that -- make it workable so that we can avoid any such freelancing in the future. >> let me say, mr. chairman, you have taken a lot of heat, but in the final legislative battle in terms of legislative product, i think you did pretty well defending your position in the way the final legislation was written. one last question in terms of comparisons, which are always questions that we wind up trying to examine, because we don't know what happened behind closed doors. now of how was lehman different

from aig? if there was a run on aig, capital was locked up in insurance subacid can i ry, what was the difference? >> there was a fundamental difference. again, the issue was, could we make a loan that was adequately secured, that was reasonably likely to be paid back. the -- unlike lehman, which was a financial concern and whose entire going concern value was in its operations, aig was the largest insurance company in america, and the financial products division, which got in to the trouble was just one outpost of this very large and valuable insurance company. and therefore, -- and in fact, that's why they created this, because they wanted to ride on the coat that's of the aaa rating of aig, so unlike lehman, which didn't have any going

concern value or not very much, aig had a very substantial business, huge business, more than a trillion dollars in hey sets, and a large insurance business that could be used as collateral to borrow the cash needed to meet financial products liquidity demand. so that's a very big difference and indeed, the federal reserve will absolutely be paid back by aig. >> thank you, mr. chairman. i just want to thank you once again for, in political terms, your bravery and willingness to move in the way that you did. thank you very much. >> thank you for joining us today, mr. bernanke. after reading and re-reading your prepared testimony, with all respect, i find a less than thorough discussion of one area that i think is exceedingly important, which is the erosion of market discipline associated with the creation of the engineered financial instruments that became toxic assets on the balance sheets of our financial institutions.

these assets became a significant cause of the liquidity crisis, based by these institutions, when they couldn't meet their obligations, either because they couldn't so many the assets without a steep discount, an ever increasing discount and couldn't borrow against the assets as collateral, except with a large and increasing haircut and of course, when they faced the last, they turned to the american taxpayer and the federal reserve and others to essentially rescue them from their excesses. you've spoken to the deterioration and mortgage originallation standards, they were problematic to be sure, caused in many institutions by differential awards to financial regulators, who were paid more to steer borrowers that produced greater returns to the mortgage holders and greater costs to the borrower, which resulted in a higher likelihood of default by

the bore would youer. without regard to its success or failure to perform as represented to the investor owners. the underwriting investment banks legally responsible for the exercise of due diligence on the products, the lawyers who drafted the prospectuses, the accountants who created the accompanying financial statements, the credit rating agencies that rated these securities, all received their fees in cash when the securities were sold and only if they were sold. so is it any surprise that every participant in the chain opined that everything was in order, when we know that it was not? some 92 to 94% of the mortgage-backed securities and thyratron muchs that were created that were rated aaa have been downgraded and many of them exceedingly severely and we're not speaking here simply of mortgage-backed securities, but collateralized debt obligation,

in which miraculously they take the trip b tronchs of mortgage backed securities and miraculously put them altogether and make a security that's not rated just aaa, but a product that can fail and fail they did. then we go to synthetic cdo's, which are creations which are essentially bets on the success or failure of the underlying other securities. when they didn't have other things to sell. so the financial reform legislation attempts to address some of these problems by prohibiting differential compensation to mortgage originators, for steering borrowers to riskier products and requiring issuers to hold 5% of the product they created. since it seems to me that nothing focuses the mind of wall street bankers more than having their own money at rings an their own skin in the game, it

is hoped that greater discipline and diligence will be exercised when the the creator knows that their own financial future depends on the performance of their creation, so i apologize for such a long introduction, dr. bernanke, but i wonder, would ask you to comment on the initiatives put in place by the federal reserve in exercising its responsibility to be the safeguard of the safety and soundness of america's financial institutions to address some of these issues. >> sure. i did refer in my testimony to the problems with the originate to distribute model, which goes all the way from the initial mortgage loan to securitization and there were clearly a lot of problems there. we are trying to address them, although as i said earlier, we were late in developing mortgage underwriting standards under hoepa. we did in 2007-2008 did establish some very strong standards and i'm sure they'll be maintained by the new consumer protection agency. we also have put out -- we also have banned, the fed presever

has banned yield spread premiums, which allow lenders to be compensated on the basis of the type of mortgage that they provide, and so we've tried to address the front end of origination to distribute. on skin in the game, i think we all agree that we want to create good incentives, and that is one way to do it, and the fed is also involved in making sure that incentive compensation contracts for both executives and other employees of financial firms reflect appropriately the long run returns of their activities and not the short run returns as you were describing. the only thing -- >> if i could just probe you on that. how would you propose to rejigger those compensation incentives to reflect the long-term performance? >> well, we're asking the -- since the nature of the business differs across institutions, we're asking for proposals, we're asking for companies to show us what they're going to do

and we work with them and make sure we're satisfied. the basic principle is that return should depend, first of all, they jobberies being adjusted, so if you take a riskier action, that should be taken into account and secondly, a longer horizon, not just whether you made the sale or made the deal, but rather, how did it work out over a number of years an things like non-vested stock and things of that sort are ways to achieve that, so that's another step. >> and some have suggested a basket, an index based on a basket of the securities created, so that you can actually track over time the success or failure of those securities and compensate people more or less depending on how they perform. >> for capitalism to work, you have to have incentives tied to performance and i think one of the things people are very upset about is the fact it seems like a lot of people who drove their companies into the ditch walked move with lots of money and that's not good capitalism and it's not good for -- it's not a good ethical outcome either. the only comment i would make, one thing which is puzzling in a

way, is that these firms that package securities, whether it's by mistake or not, ended up being pretty exposed to them and they took a lot of losses in many cases, and so we have to figure out why, even though they were still exposed to these securitized products, they weren't more careful, but that's clearly a key issue. >> thank you. and i think the answer at the end there is sometimes they just got caught without being able to sell them hall. i mean, you know, it is a game to some extent, when there's musical chairs, the music stops and you're not necessarily finding a seat, and i think that to some extent happened to some of these institutions. let me turn -- i appreciate your considerations, and i encourage you, as you look at these institutions, on a go forward basis, you consider that kind of -- those kinds of thoughts as you evaluate their soundness. >> there's some data that we've seen that suggests that the

sixth largest u.s. banking organizations, b of a, jp morgan chase, citigroup, wells fargo, goldman sachs and stanley, now are actually larger as a result of mergers and the elimination of other institutions, than they were even in 2007, just before the height of the crisis. that apparently, they were 58% of g.d.p. in 2007, something like 68% of g.d.p. in 2009, which had gone up from 17% of g.d.p. in 1995, so there's been a consolidation and a growth, and i guess, my question to you, would be, given their increasing size, do you really believe that these institutions wouldn't be allowed -- would or would not be allowed to fail by the fed if they got into financial trouble today? i mean, i hope it doesn't happen, but let's just say for the sake of argument, that a diminution in some other asset class results in serious stress

to both the balance sheet and the liquidity needs of these institutions. are we really in any better shape today to avoid the bailouts that have been so criticized in the last few years? >> the federal reserve was created, but we were always well within the law and we always did -- only exerted our legal powers and the changes in the bell, that was just passed, has, for example, eliminated the ability of the fed receiver to lend to -- federal reserve to lend to a financial institution and it has spes need how we must deal with a stemically critical firm, so you know, borrowing some midnight session of congress, which rewrites the law, i don't see any way that it would be feasible. for the government to bail out a firm in the same way that happened during the crisis. so it's very important that we make sure that our methods that we do have, the resolution regime, etc., that they work. and that's something we're very much engaged on. i think it's also very important that we make sure the firms,

we're always going to have big and complicated firms, we want to make sure they're big and complicated for the right reasons, good economic reasons and not because they're simply trying to hide behind too big to fail and my believe is that again, the combination of tougher oversight, additional capital required for systematically critical firms, tougher resolution regime and those things are going to take away some of the attractiveness to firms of being too big and will, i think, help us over time, and with market discipline, reduce the size and complexity of some of these firms. >> i noted on page 17 of your prepared testimony, you did speak to the size of the firms and the, in certain respects, its unmanageability and unmanageability with regard to risk of some of the institutio institutions. i wonder if some have suggested that they've simply gotten too large. i'm not sure i agree. i understand the notion that we need large institutions to compete in a global marketplace, and to meet the financing needs

of large -- our own large corporations and other borrowers, but it's not inconceivable and commonly utilized that when a large credit facility is necessary, people enter into syndicates, if the one bank isn't big enough, somebody or one or two of them take a lead and bring others in, and so you still end up pulling together the resources necessary. you know, we've had some extraordinarily startling testimony in the course of hour eight months or so of hearings. we heard from the c.e.o., the chief financial officer and the chief risk officer of aig that they did not know that the products sold by the financial products division, had provisions in them, that if the aig's ratings wept down or the tronchs that they had insured against the credit default swaps, the credit they insured

against went down, that they had collateral calls, which were ultimately what brought aig to the brink of insolvency, and the same, similar kind of astonishing testimony from citigroup's then c.e.o., chief financial officer and keefe risk officer that they did not know, that their banking subsidiary had sold collateralized obligations with a liquidity put that if they were downgraded permitted the holders to essentially put them back to citibank, to the main holding company and they did so, one day, they took $25 billion and bought this stuff back, which was a third of their then capital, of $75 billion on some 3.3 trillion of assets. these were astonishing risk management failures and some have even speculated that really, they couldn't possibly have meant it when they testified here that they didn't know, but assuming for the sake of argument that they did not

know, that really can't -- ought not to occur on a go forward basis, so are these institutions so complex, and so diverse, in their product mix, that they've become too large to manage, and if that's the problem, then how do we address that from the fed presever's perspective -- fe federal reserve's perspective. >> it's our responsibility and the other regulators to make sure that their management is effective and they have good risk management systems and if we are persuaded that they cannot manage the risks of the corporation, because it's too large or complex, we are able, we have the ability to make them distributiodivest or change thee and that's even accounting the new authority, if a firm is viewed as being systematically risky that it can be broken up on those grounds as well, so we do have authority there, and in the case of citigroup, they have put a substantial portion of

their company, put it into a separate structure, which is being sold off, so i agree with you, that where there is failure of risk management or business macment, because of size or complexity, it's very important that the firm and the regulators work to address the problem, and i assure you that we will. >> thank you very much. if i might, could i reserve two minutes of my time? >> you have 1:17, but we will graciously grants you the 44 seconds. >> thank you very much. >> thank you, mr. chairman. and thank you, mr. chairman, for spending this time with us today, and i guess i'd like to follow the -- those who are preceding me in thanking you for your service in this difficult period and for the fed receiver into this -- federal reserve for this inquiry.

it's been very helpful. i don't have a particularly systemic set of questions. i have a couple of things i'm curious about. i want to go back to the trigger, the housing bubble subprime crisis. you touched on this in your testimony. could you walk us through your view of the causes of the housing bubble and i'm interested in the points of recognition within the federal reserve when we had a housing bubble and sort of what your policy options were in light of that. >> so bubbles by their very nature are difficult to understand, even after of the fact. the house prices began to increase fairly rapidly in the middle to late 1990's, and then of course, they accelerated to some extent in the early 2000's and peaked in 2005, 2006. my only view is that there are many actors con -- many factors contributed to that. in my testimony, i discussed two that was important. one was the interaction of

expectation optimism on the one hand and innovation and mortgage instruments on the other, and what you saw was hand increased willingness on the part of lenders to make loans to people who were really not qualified on the expectation that appreciation in the value of their homes would allow them, by giving them more equity, would allow them to refinance into more standard instruments and what we saw as the crisis progressed, was increasingly sketchy instruments, that had -- if they had even existed prior had been reserved only to very limited groups of customers, but now you had people who had not bought a house before, using option arms and interest only and other complex mortgage instruments, whose primary purpose was to bring the monthly payment to as low a level as possible. and again, that worked okay, as long as prices were rising, but of course, prices couldn't rise forever and once they stopped rising, the whole process unwound, so i think that was

very important, and people like bob schiller have been pioneers in identifying those issues. another ac factor, which i have talked about since 2005, is so-called global saving glut. all that really means is for a variety of reasons and the timing here works well, going back into the 1990's, its u.s. has been a major recipient of global capital flows and lot of those capital flows have gone into relatively safe fixed income instruments like mortgage backed securities or securitized credit products and that includes not only the excess savings from asia and emerging markets but also the gross savings from markets like europe and asia looking for those type of instruments, so that demand both reduced mortgage rates and reduced spreads and gave investment houses in the u.s. and elsewhere an incentive to create these new products, the alchemy, making uncertain

mortgages and by restructuring them, creating the tronchs of so-called super a. the controversial issues, because it matters so much for the future, how monetary policy is conduct, what role the monetary policy played and there's a lot of conventional wisdom about this and i think the only honest answer is we really don't know exactly how big the role was, but i've tried to give some arguments, why i think the view that monetary policy was a principal cause is not supported by the evidence, and i can repeat that if you'd like, but very briefly, there was the fact that the previous relationships, between monetary policy and housing prices, don't look remotely like they would have had to have been in order to account for the increasing house prices in the recent episode. cross country, we don't see issue between monetary policy and housing prices, and finally, i think, even if there had been some relationship, it would have

been very questionable that we should have, you know, substantially raised interest rates in the situation of 2003 2003-2004, given what was happening in the macro economy as an attempt to try to close off the housing bubble. my strong preference and i said this in my very first speech as a governor in 2002, that we should use supervision and regulation to approach bubbles. we didn't do that. >> thank you. >> going forward, we need to be able to do that and that's very important. on the fed's views, the fed is taking criticism for not, quote, recognizing the obvious etc. we knew that house prices were rising quickly, but as of 2003-2004, there really was quite a bit of disagreement among economists about whether there was a bubble, how big it was, whether it was just a local or a national bubble. so we were certainly aware of that risk factor, but you know, frankly, we by time, it was

evident that it was a bubble and it was going to create rusk to the financial system, it was rather late to address it through a monetary policy. : the thinking was if house prices did come down some, and the 30% was not what people were contemplating, the economy could manage that ok. i said what i said. it was based on the observation that even under bets scenarios, the total losses in adjustable- rate mortgages were unlikely to be more than $400 million, which is a lot of money, but compared to financial markets, $60

trillion of equity in markets around the laconic it was a small amount of money. the loss of $300 million in equity would mean almost nothing to the economy. the financial system had these vulnerabilities and weaknesses, which i talked about in my testimony. what was a relatively small factory in the scheme of things triggered these weaknesses and led to a bigger crisis. what i did not recognize was that -- my view was the losses were going to be manageable. i did not recognize the extent to which the system had flaws and weaknesses in it that were going to amplify the initial shocks of sub-prime and make it into a bigger crisis. system had flaws that would amplify the initial shock from sub prime to

make it a much bigger crisis. >> i want to talk a little bit about the institutions of we investigate going forward. has it bleeds into the broader financial markets, what institutions are you watching carefully and by what criteria are you selecting the ones you are really worried about? >> you mean today? >> at the time. what was the nature of the fed's criteria for identifying institutions they need to be on watch for? >> to begin with, is important to remember that the fed was not a systemic regulator at the time. we had some specific responsibilities for bankholding companies principally. we did not have responsibilities for aig or invested banks or fannie and freddie or mortgage bankers. many of the areas where there were problems we simply did not

have ongoing authority or supervisory presence. and so we did not get heavily involved in those situations until well into the crisis. around the time of bear stearns when it was evidence that some financial institutions were under a lot of stress. the treasury and to some extent the fdic and other agencies were coming together to address them. we came rather late. that was simply the nature of our responsibilities. in terms of which firms to pay attention to, there are multiple criteria. size is important. but it is not the only criteria. for example bear stearns was not that much larger but bear stearns was a much more complex firm.

it had large presence in the try party money market and in securities lending and other short-term financing. ahead large derivatives so it was very interconnected. a very important aspect of the prices was a rolling panic. the notion that if confidence lost firms that were vulnerable from a liquidity point of view came under attack. stock market reduced confidence as well. it was our view that the failure of bear stearns would lead to the same effect we saw with lehman brothers six months later. huge stresses in the repo markets and other money markets. those short-term liquidity stresses would feed into other firms even the ones without

direct counterparty relationships. those criteria, size, interconnectedness, complexity and performance of critical functions. so for example, banks like j.p. morgan and wachovia had very important roles in various payments and settlements and infrastructure type aspect in the financial system and that was additional considerations. >> i don't want to put words in your mouth but when we talked to former undersecretary steal it really appeared that what mattered most was interconnectedness and complexity but which markets were showing signs of distress and panic and that was the criteria for intervention and the reason i want to push this is in the sort of new legislation there is a lot of thinking about who is going to

be a systemically important institution which doesn't appear you could anticipate because you don't know the market -- is that a fair concern? >> it is a fair concern. the legislation requires us to identify systemically important institutions for the purposes of oversight but i don't need you to be identified for the resolution to apply it to the firm. that is a decision that is made at the time. >> how could they prepare a living will if they have not been identified as someone who should be resolved? >> for firms that are on the cost if you will, prudence might have as work with them on these issues in any case. that would be important for complex for is but you raise an important point. >> the second question, on the living will, by wonder how you

think about this, we relied on the past of systems of internal risk assessment as a substitute for direct measurement of the risk exposure to firms because of the assessment of risks. firms are too difficult to resolve rely on their plans for resolving themselves if we don't understand how to do it? >> it sounds like the same thing. they havave to come up with the plan. they are better placed than we are to figure out the best way to unwind the firm but we have to take responsibility with their cooperation and assuring ourselves that is a workable plan and responsibility for that is the fed and the fdic and other regulators relevant so we put together a lot of expertise to figure that out. at the fed, the lesson we took from the crisis is we really need to take a much broader,

mulford disciplinary approach. we need more economists, more payment people, more accountants to supervise the supervisory activities to make sure we have the perspective we need to get this done. >> going back to as the crisis unfolded and the fed's decisions about where to intervene with institutions. i want to ask again about lehman brothers versus a ig, thinking of the criteria for intervention. i'm not sure i understand what you said about a ig making a loan in that case. i want to walk through the logic of that because you said you didn't want to loan to lehman brothers because they didn't have sufficient assets and it wouldn't get repaid.

aig had no buyer. there was clearly a liquidity run. you do is ultimately lind into it and had to go back and lend a lot more in short order so it didn't look like you stop it. it looked like it continued. what i am confused about is your assessment of the ability to repay because lot of the assets were not available as collateral for -- the insurance division's in the firm. what is the difference in the thinking of lehman brothers versus aig. >> two additional minutes. >> both of them met the criteria for trying to save them a federal possible and were systemically critical. aig had